what is ROEL - ROEU?

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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4. You work for the CEO of a new company that plans to manufacture and sell a new product, a watch that has an
embedded TV set and a magnifying glass crystal. The issue now is how to finance the company, with only equity or with
a mix of debt and equity. Expected operating income is $500,000. Other data for the firm are shown below. How much
higher or lower will the firm's expected ROE be if it uses some debt rather than all equity, i.e., what is ROEL - ROEU? Do
not round your intermediate calculations.
0% Debt, U
60% Debt, L
$500,000
$2,500,000
Oper. income (EBIT)
Required investment
% Debt
$ of Debt
$ of Common equity
$500,000
$2,500,000
0.0%
60.0%
$0.00
$1,500,000
$1,000,000
$2,500,000
NA
Interest rate
10.00%
Tax rate
35%
35%
a. 11.21%
b. 8.29%
c. 9.75%
d. 11.70%
e. 8.78%
Transcribed Image Text:4. You work for the CEO of a new company that plans to manufacture and sell a new product, a watch that has an embedded TV set and a magnifying glass crystal. The issue now is how to finance the company, with only equity or with a mix of debt and equity. Expected operating income is $500,000. Other data for the firm are shown below. How much higher or lower will the firm's expected ROE be if it uses some debt rather than all equity, i.e., what is ROEL - ROEU? Do not round your intermediate calculations. 0% Debt, U 60% Debt, L $500,000 $2,500,000 Oper. income (EBIT) Required investment % Debt $ of Debt $ of Common equity $500,000 $2,500,000 0.0% 60.0% $0.00 $1,500,000 $1,000,000 $2,500,000 NA Interest rate 10.00% Tax rate 35% 35% a. 11.21% b. 8.29% c. 9.75% d. 11.70% e. 8.78%
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